The term “negative gearing” has been thrown around since the 1980’s. The concept was originally introduced to encourage those who could afford it, to purchase an investment property, thus increasing the number of rental properties on the market to meet the demand. But what is negative gearing exactly?
According to Mortgage Choice, negative gearing “… occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.”
Throughout the noughties (2000 – 2010) many investors were encouraged by well meaning but non-property savvy accountants to invest in negatively geared properties to reduce their taxable income. But many investors on average incomes found themselves trapped by negatively geared properties they simply weren’t earning enough to pay for, let alone build the financial freedom they expected. All they ended up with were crippling bills to cover the gap between what the property earned via rent and what the property actually cost each month. Dreams of building 2-5-10 properties were crushed as there wasn’t enough cash left over each month to consider gap repayments for additional properties.
In an investment sense, gearing means borrowing. When you engage in negative gearing, you effectively run your investment at a loss. The plan is to make the loss only short- term. In the long run, the capital gain on a house or unit that you hold for say, 10 years, can skyrocket in value, if you manage to buy in an area that experiences exponential growth. Even if there is only an average real estate gain, the strategy can pay dividends, though some people who buy badly can lose in the long run with negative gearing.
In the short-term, you are still losing on the property, but you are betting that the capital gain on the house or unit outweighs the loss and the eventual capital gains tax you pay if you sell the property.
Before you make the commitment to buy a negatively geared property you need to do your sums. Is the tax benefit significant enough to warrant the potential losses? Ask yourself these questions:
- Will I just buy one property or do I want to build a property portfolio?
- Do I want it purely for growth?
- Do I want it purely for income generation?
- Do I want a combination of both growth and income?
- And most importantly – what can I actually afford?
Before you go ahead on the advice of your accountant and start looking for property, you need to have a clear plan in place. Know exactly what you want to achieve from your property purchase, how much it is going to cost you to maintain (not only in today’s low interest rate environment), and have a clear defined path for getting there.
Secondly, don’t try to go it alone. It is absolutely imperative that you engage a team of industry experts to help you stay on course. This would include a property focused accountant, a mortgage broker to get you the best finance deals, a buyers agent who can do the leg work for you to find the perfect property and a proactive property manager to ensure you achieve the best possible yields.
If you’re interested in finding a negatively geared property, or developing an effective wealth creation strategy, please join us at our next educational workshop titled Invest like a pro, so you never need worry about money again.
Innovative Property Advocates have more than 20 years experience in the property industry. We can find you the perfect investment property to compliment your portfolio and manage the property into the future. For more information call today on 1300 732 488.
* Image source: http://www.australianinvestmentrealty.com.au/images/house_leverage.jpg
** article references: Switzer Guide to Personal Investing, Mortgage Choice
